Challenges and Opportunities in Overseas Equity Markets

1
Challenges and Opportunities in Overseas Equity
Markets

• Dominic Rossi
• Head of Global Equities
• Threadneedle Investments

2
Healthy world economy
Moderate, non-inflationary growth
Source Threadneedle Investments As at 30
September 2006
3
Interest rates have peaked in the US
Rates converging next year

Source Datastream
4
Equities Overweight
Global P.E.
1988 2006

• We see a healthy economic background for the
  major economies. We see reasonable growth levels,
  and do not expect any significant pick-up in
  inflation
• The fall in markets over the summer has taken
  valuation levels in terms of price/earnings
  ratios down toward the lowest levels seen in the
  last 15 years
• Strong cash generation by companies has led to
  high levels of dividend growth. We expect 2006
  to be another year of strong dividend growth in
  the major regions
• MA activity will offer additional support for
  markets

Dividend growth
Actual 2004, 2005 and Threadneedles Forecasts
for 2006
Global total cash yield and 1 yr. fwd global
equity returns
As at 31 May 2006
, 12 Month Forward Equity Return
5.0
Total Yield
Total Cash Yield
4.5
4.0
3.5
3.0
2.5
2.0
1.5
12 Month Forward Returns (LHS)
1.0
Source IBES, Exshare, FTSE, Lehman
Brothers Source Citigroup/Threadneedle Source
Lehman Brothers. Composed of dividend yield, 12
month trailing net buy-back yield, and 12 month
trailing cash financed MA yield.
5
Equities are cheap relative to bonds
Global Equity PE Ratio and Bond Yields

Source Lehman Live, Datastream
6
The major world equity markets are shrinking
Equitisation growth by region


Buy now while stocks last
Source Citigroup
7
US Equities Underweight

• We expect reasonable growth going forward with
  inflation contained
• Profit cycle will continue despite current high
  margin structure
• Dollar stable
• ROE no longer superior to the rest of the world

US Official Rates
Sept 2004 Sept 2006
US to Euro Exchange Rates
Jan 2000 Sept 2006
Source Datastream
8
Return on Equity is approaching historic highs
Return on Equity

Source Morgan Stanley
9
Japan Equities Overweight
Japanese inflation

• We expect above trend economic growth of 2.8 in
  2006 and 2007. Export demand and capex have been
  strong, and the outlook for domestic consumption
  is improving
• The end of the quantitative easing policy and
  the zero interest rate policy show a steady
  return to normal conditions
• Inflation, as measured by CPI, has now been
  trending higher year-on-year for several months.
  Property prices have also started to rise
• Profit margins are starting to catch-up with
  those in other developed economies. We expect
  earnings growth in Japan to be the strongest of
  the major markets in both 2006 and 2007

15 July 1996 to 15 July 2006
Corporate earnings
2005 - 2007
39
40
30
18
20

13
10
0
2006 (e)
2007 (e)
2005
Source Thomson Financial Source Threadneedle
10
JapanUnderperformed in 2006

• Negatives
• Livedoor scandal
• Mothers Index down over 50 year to date
• End of quantitative easing
• First blue chip hostile takeover thwarted
• Recent soft macro data

Mothers figure source Datastream in sterling as
at 14 September 2006
11
JapanUnderperformed in 2006
Return on Equity versus TOPIX

• Positives
• Restructuring and rising return on equity
• Superior medium-term profit growth
• Similar dividend and bond yields
• Property market still buoyant

8.8
Remain overweight
Source Goldman Sachs
12
Asia Ex-Japan EquitiesOverweight
China

• Growth in China remains very strong. We expect
  GDP growth of 10 in 2006
• We do not expect recent Chinese monetary
  tightening to have any significant impact on
  growth
• The Indian economy is also showing rapid growth.
  We expect GDP of around 8 in the current year
• Markets are cheap relative to other regions and
  relative to historic levels

GDP Growth ( YOY)
Prospective Price/Earnings ratio
Asia Pacific Prospective P/E Jan 88 August 06
Source JP Morgan as at 26 September
2006Source Merrill Lynch as at 26 September
2006
13
European EquitiesOverweight
European PE (ex UK)
As at September 2006

• There are growing signs of economic recovery. We
  have recently raised our GDP forecast for 2006
• Equity valuations are attractive, particularly
  equity yields relative to bond yields
• Reform and EU expansion are keeping downward
  pressure on wages especially in Germany. This is
  beneficial for profits
• Q2 2006 results have been encouraging. The ratio
  of positive surprises to negative surprises was
  very favourable at 2.5 to 1
• MA activity has picked up globally. The UK
  market is one of the most open markets for
  takeover activity

Major companies acquired in last 12 months
(or acquisition agreed)
Source DatastreamSource ABN AMRO
14
Global sector strategy

• We continue to favour quality growth stocks
• We are overweight resources, expecting strong
  demand and limited supply to keep prices firm
• We like healthcare, due to the long-term growth
  opportunities arising from demographic change
• Basic industries and industrials should benefit
  from the pick-up in capex and we see some signs
  of pricing power in this area
• Other financials are overweight as a geared play
  on rising markets

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Are material stocks in a Nasdaq-style bubble?
Information Technology sector

• Rapid rise in returns on capital in the late
  1990s
• Accompanied by a collapse in the cost of capital
• Led to capital indiscipline
• A text book example of the laws of diminishing
  returns

Source CSFB Holt
16
Material stocks?
Material Sector

• Returns on capital have risen sharply
• But discount rates have not fallen
• Asset growth remains restrained
• No sign of capital indiscipline as the cash is
  returned to shareholders

Source CSFB Holt
17
Global Healthcare
Global Healthcare

• Different characteristics to material sector
• Stable returns on capital
• More volatile discount rate
• De-rating since 1999 now looks complete
• Offer lots of potential

Source CSFB Holt
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Summary

• We remain overweight equities
• Favoured areas remain the UK, Japan, Europe ex UK
  and Asia Pacific
• Our equity strategy is to focus on quality growth
  franchises
• Our favoured sectors include resources,
  healthcare and other financials

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Important Notes
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and the income from them is not guaranteed and
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overseas investments. The mention of specific
shares should not be taken as a recommendation to
deal. The research or analysis included herein
has been produced by Threadneedle Asset
Management Limited for its own investment
management activities. It may have been acted
upon prior to the publication of this document
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